Racketeering Law Gets New Scrutiny With Drexel Case

WASHINGTON —  It is a business nightmare--and a small investor’s dream. Investors, understandably furious when highly touted investments turn sour, are learning that they may fight back with a federal law that was originally designed to strike at Mafia dons and big-time drug dealers.

The law is RICO, the Racketeer Influenced and Corrupt Organizations Act. Companies found to violate it--as well as stockbrokers and accountants--can be forced to pay investors triple damages and attorneys’ fees besides.

The law is receiving increasing attention because the federal government is preparing to file a massive criminal RICO complaint against the New York investment firm Drexel Burnham Lambert and Michael Milken, its Beverly Hills-based guru of “junk bonds,” charging that they illegally used inside information to make profits in the markets.

With its provision for triple damages, RICO could mean hundreds of millions of dollars in potential liabilities for Drexel.

And even more significantly, a criminal conviction of Drexel could open the floodgates to a torrent of civil lawsuits from aggrieved investors, all asserting that they were victims of insider trading. Securities-related cases already account for nearly one in five civil RICO suits filed each year, experts estimate.

“Our companies are suing and being sued” under RICO, said John Pilcher, director of corporate finance for the National Assn. of Manufacturers. “It’s bad pressure on everybody that does business.”

To consumer groups, however, RICO is the ultimate weapon against corporate greed.

Deterrent Value

“It’s the only federal statute individual victims of white-collar crime can effectively use,” said Pamela J. Gilbert, staff attorney and lobbyist for the U.S. Public Interest Research Group. The prospect of winning triple damages plus legal fees makes the stakes high enough for aggrieved consumers to get legal help they could not otherwise afford.

Philip A. Feigin, Colorado’s securities commissioner, says RICO enables individuals to act as private attorneys general in fighting white collar-crime, particularly in the securities field. Criminal suits aside, he says, civil suits by individuals threaten enough punishment to deter would-be violators of securities laws.

“The opponents of RICO say there are abuses,” Feigin told Congress on behalf of the North American Securities Administrators Assn. “But we we have our horror stories, too. Ivan Boesky is a horror story. If we really want to cope with true white-collar crime, we have to use every weapon available.”

These drastically clashing views of RICO have yielded a stalemate in Congress.

Industry, led by the Securities Industry Assn., mounted a determined drive earlier this year to soften the law as it applies to civil suits. Sen. Howard M. Metzenbaum (D-Ohio), usually an opponent of big business, proposed a bill to restrict penalties in civil cases to actual damages, thus curbing RICO’s extraordinary economic punishment.

“The anti-racketeering law needs reform because it has been used in ordinary commercial disputes that do not involve criminal activities.” he said.

However, Metzenbaum sought to keep triple damages for suits involving small investors--those with portfolios of $10,000 or less--and for cases of insider trading.

That did not satisfy business. Donald J. Crawford, senior vice president and director of government relations for the Securities Industry Assn., said 75% of RICO cases would still have been subject to triple damages. “Why should we accept that?” Crawford demanded.

The Senate Judiciary Committee, siding with business, voted 11-2 to dispose of Metzenbaum’s small-investor clause.

But if business won the battle, it lost the war. Consumer groups led by the Public Interest Research Group lobbied hard against the bill, and it died without clearing either the Senate or the House.

RICO covers a long list of criminal acts, from murder and extortion to securities fraud, mail fraud and wire fraud. Conviction--under either criminal cases brought by the government or civil cases brought by individuals or companies--requires a finding of a “pattern” of criminal behavior.

Although RICO was enacted in 1970, it became commonplace in commercial disputes only in 1985. The Supreme Court ruled that year that RICO could be used by individuals or businesses in civil suits even if a defendant had not been convicted in a criminal RICO case.

Since that ruling, about 1,000 civil RICO cases are filed annually in the federal courts. Notre Dame Prof. G. Robert Blakey, who drafted the original RICO statute as a Senate aide, said the largest involved International Business Machines’ suit against Hitachi for theft of computer secrets. Hitachi paid $200 million in an out-of-court settlement.

Strayed Far From Aims

RICO cases always are “serious cases, in the hundreds of thousands of dollars or more,” Blakey said. “You can’t seriously litigate in federal court unless both sides put up a couple of hundred thousand dollars.”

About 19% of RICO cases, Blakey said, have involved the securities industry. And that industry has reacted in much the same way as others that have been the target of RICO cases.

“I don’t think the securities industry is different from any other industry, which looks upon RICO as a statute that has been misapplied,” said Thomas Schick, executive vice president for government affairs at Shearson Lehman Hutton. “In connection with an industry like ours, it is used almost as a matter of course by people who feel they have been aggrieved--it’s a wonderful club for the plaintiffs.”

The securities industry has a multiplicity of allies in its drive to rewrite RICO, including the National Assn. of Manufacturers, the U.S. Chamber of Commerce and trade groups representing accountants, automobile dealers, bankers, insurance agents and grocery manufacturers. The AFL-CIO--disturbed because unions have been hit with RICO suits--and the American Civil Liberties Union also joined the coalition.

“RICO litigation has strayed so far from its original aims that it now encompasses everything from securities transactions and garden-variety fraud cases to landlord-tenant and attorney-client conflicts, as well as employment grievances and even divorces cases,” according to the Washington Legal Foundation. That group has submitted a brief in a case asking the U.S. Supreme Court to define more closely the law’s “pattern” of racketeering activity.

Companies are upset that RICO allows opposition lawyers to demand books and records going back six years, said the securities industry’s Crawford. “It’s a broad ‘witch-hunting’ discovery process.”

Dismiss Many Cases

Business executives pushing for reform cite the potentially ridiculous aspects of the law.

“Suppose your company sells widgets, a customer orders Size 5 and they come out Size 4,” said John Pilcher of the National Assn. of Manufacturers. The unhappy customer, Pilcher said, “doesn’t just sue for his money back, and lost production time, he also asks for triple damages under RICO. He claims the two conversations he had in which you promised Size 5 widgets are two counts of wire fraud.”

David Hyman, director of compliance for Bear, Stearns & Co., a major brokerage firm, complained that lawyers, tempted by the prospect of big awards, sometimes “run amok with frivolous charges.”

But Blakey, who drafted the act, said the federal courts dismiss about half of all cases. “If they smell a frivolous case, it’s gone,” he said.

Pamela Gilbert, of the Public Interest Research Group, agrees. She insisted that industry really “is worried about legitimate claims that could cost a lot of money.” Before RICO, she said, companies could “engage in criminal behavior and not have a lot to fear.”

Julian Epstein, a spokesman for Rep. John Conyers (D-Mich.), who blocked the proposed RICO modifications in the House last year, insisted that “treble damages serve a very important deterrent value.” “Fraud and white-collar crime cost the economy $200 billion a year. Very little of that money is recovered through criminal or civil proceedings. It’s ridiculous to weaken one of the few methods for few civil remedies.”

Theodore G. Eppenstein, a prominent securities lawyer, said there was no “groundswell to find the brokerage industry in violation of RICO” because the charges are so hard to make stick. “If you have a case where hundreds of millions of dollars are extorted over a period of time, and many people involved and the brokerage firm knew what was going on, that would fall under the statute,” he said.

A Costly Battle

RICO’s defenders say they are willing to tighten the definition of “patterns” of criminal behavior and to add penalties against the filing of frivolous complaints. But they insist on keeping triple damages.

“I will continue to press for reforms that will protect small investors as well,” said Sen. Metzenbaum, who wants shareholders with average incomes and modest stock portfolios to retain the option of collecting triple damages.

Jockeying over RICO has been fierce--and costly. Drexel, for example, paid more than $200,000 to the prominent Washington law firm of Akin, Gump, Strauss, Hauer & Feld just to monitor the RICO legislation.

However, the law firm “took no active role” in lobbying on the issue, a Drexel spokesman said. “We did not take a position.”

Crawford, the securities industry official, confirmed that. “They did not participate in any of the negotiations I was involved in,” he said.

The securities industry is taking pains to point out that its proposed modifications of RICO are not prompted by an effort to defend violators of insider trading rules.

For Boesky and others convicted of various crimes, the attitude is to “get them,” Crawford said. “Treble damages is too good for them. The strong feeling is that if you want to kill them 10 times, that is fine with us.”

And nobody in business is suggesting any alterations in the criminal side of the RICO statute. None of the proposed changes would influence Rudolph W. Giuliani, the U.S. attorney in New York who is preparing the criminal case against Drexel. Giuliani is expected to have a free hand in a public climate aroused by tales of millions in illegally amassed profits.

Crawford said he could not imagine how Giuliani could conclude the Drexel case without seeking a conviction. “If he did,” Crawford said, “he would be on the witness stand in Congress from now to kingdom come.”

Whatever happens to Drexel, the effort to change RICO’s civil provisions will continue next year in Congress. “The effort started long before Drexel,” Crawford said. “There has been agitation in the industry for quite awhile.”